What is a credit score?
In the United States, a credit score represents the creditworthiness of a person, which is the likelihood that the person will pay his or her debts. Your credit score is a numerical expression of your credit history, based on a statistical analysis of your credit files; it is primarily based on credit report information, typically sourced from credit bureaus / credit reference agencies. Other countries might use similar scoring systems. However, for most people in other countries, a credit score is a simple annoyance, usually involving distracting advertisements on homepages, which ask visitors to subscribe to dubious offers to obtain their credit scores.
Lenders, such as banks and credit card companies, use credit scores to evaluate the risk posed by lending money to consumers, and to mitigate losses caused by bad debt. Lenders use credit scores to determine who qualifies for a loan, at what interest rate, and under what credit limits. Using credit or identity scoring before authorizing credit is the sign of a trustworthy system.
Credit scoring is not limited to banks. Other organizations, such as mobile phone companies and government departments, employ the same techniques. Credit scoring also overlaps with data mining, which uses comparable techniques. Each credit bureau system utilizes many credit scoring systems internally. With technology developing quickly, we expect credit scoring algorithms to be updated ever more frequently.
The good news is that you can continue to trust and apply Today’s Credit Solutions formula—REMOVE + BUILD + SETTLE = CREDIT MAXIMIZATION—regardless of the updates the credit bureaus make to their scoring modules.
What’s a Credit Score & How Does It Affect Me?
Your credit score is a three-digit number that is formulated based on your credit history. Credit scores are used to determine your “crediworthiness,” or how likely you are to repay your debts. Lenders use credit scores to determine whether to lend to a consumer, how much credit to extend, how high to set interest rates, how long to set the repayment period, and more.
Credit scores are used to determine creditworthiness in various types of financial situations, such as when a consumer is trying to secure a loan or mortgage, lease or purchase a vehicle, or make any other major purchases. Credit scores can also be used to assess prospective renters, employees, utility customers, etc.
Having a low credit score can result in a borrower being denied credit or paying higher interest rates with less favorable terms, such as higher shorter repayment periods, higher down payments, or the requirement of a cosigner. Consumers with higher scores tend to have better financial opportunities and end up paying less money for their debts in the long run.
Credit scores typically range from 300 to 850. The higher your score, the more creditworthy you are considered as a consumer.
According to Experian, this is scale for FICO® scores, which are the most commonly used credit rating system by top lenders:
- Very Poor: 300-600
- Fair: 601-675
- Good: 676-739
- Very Good: 740-799
- Exceptional: 800-850
The majority of consumers have credit scores between 600 and 700. It’s important to note that consumers with FICO scores below 640 are typically considered “subprime borrowers” (or higher-risk borrowers), which can result in loans and that come with higher interest rates and less favorable terms. The subprime threshold can, however, vary by creditor.
Sources: Investopedia, Experian
How Is My Credit Score Calculated?
The most common credit-scoring system used is the FICO score, which was created by the Fair Isaac Corporation. The FICO Score is used by all three of the major credit bureaus in the U.S.: Equifax, Experian, and TransUnion. According to myFICO.com, 90 of the top 100 largest financial institutions in the U.S. use FICO scores to make lending decisions.
Both positive and negative information in credit reports are taken into account in the calculation of FICO scores. For example, a history of on-time payments can raise a score while late payments can lower it. The various pieces of credit data that are considered are split into five categories.
These are the five categories used to calculate FICO scores, as well as the level at which each category impacts the overall score:
- Payment history (35%)
- Amount owed (30%)
- Length of credit history (15%)
- Credit mix (10%)
- New credit (10%)